Praise for BofA's Mortgage Modification Plan

(March 26) -- Even critics of the mortgage-lending industry's efforts to help struggling homeowners keep their homes are lauding Bank of America's reduced-principal approach to mortgage modifications for some 45,000 of its customers.

The much-encouraged but little-used reduced-principal approach to mortgage modifications has long been championed by federal officials and consumer advocates as the most effective type of modification.

A mortgage modification, used to make mortgage payments more affordable for struggling homeowners, typically occurs when the lender reworks the terms of an existing home loan by lowering the interest rate and exchanging an adjustable rate for a fixed rate, extending the term of the loan or both. Rarely do lenders also reduce the principal to get the payment down.

Beginning in May, BofA will forgive up to 30 percent of the loan principal of homeowners who are severely "underwater," those who owe approximately 20 percent more than their homes are worth and have missed at least two payments.

The plan harkens back to the so-called "Mod in a Box" reduced-principal modification plan the Federal Deposit Insurance Corp., under Chairwoman Sheila Bair, used on many mortgages in the 2008 federal takeover of IndyMac.

Bair has continued to encourage reduced-principal modifications because the federal Home Affordable Modification Program has come up short without them, managing fewer than 200,000 permanent modifications out of a potential 3 million to 4 million eligible homeowners.

Reducing the principal is crucial to both making the home more affordable and giving homeowners incentive to stay in a home.

"BofA's initiative responds to a widely acknowledged reality: Reducing a loan's principal balance is a crucial tool for stopping foreclosures and stabilizing the housing market. We urge all major lenders and loan servicers to follow BofA's lead immediately," the Center for Responsible Lending wrote in response to the BofA's move.

BofA's "National Homeownership Retention Program" targets homeowners with certain loans that left borrowers with underwater mortgages:

• Subprime loans: a general category of loan often obtained by those who couldn't qualify for a cheaper "prime" mortgage. Subprimes typically came with higher interest rates, but also no or low down payments, little or no income and asset documentation (hence the "NINJA" loan moniker -- No Income, No Job or Assets) and other risky and easy-qualifying terms, including early refinance or payoff penalties.
• Pay-option ARMs: a type of subprime, adjustable-rate mortgage that gave borrowers the option of paying interest only or even less in some cases, causing the principal balance of the mortgage to rise ("negative amortization") rather than be paid down.
• Prime two-year hybrid ARMs: mortgages that have fixed rates for two years and then become adjustable-rate mortgages, typically with much higher interest rates.

All these loans and other risky mortgages were used during boom times to get people into homes for an affordable monthly payment, with hopes that in the coming years, incomes would grow to afford the higher payment or appreciation and equity growth would allow people to refinance out of the risky loan.

But the boom went bust and now more than 11.3 million homeowners are underwater on their mortgages, according to First American Core Logic.

Under BofA's plan, by reducing the principal, the bank would modify the mortgage sufficiently so that payments would equal 31 percent of household income. The level is considered an affordable and manageable payment for most households.

When a 30 percent reduction in the principal isn't enough to reach the 31 percent threshold, reduced interest rates will be added to the modification to further increase affordability, BofA said.

For pay-option loans, the bank said it will also eliminate the negative amortization feature and forgive all or part of negative amortization to reduce the principal to as low as 95 percent of the value of the home.

"In our experience with Home Affordable Modification Program and National Homeownership Retention Program modifications, Bank of America has found that many homeowners who owe considerably more on their mortgages than their homes are worth are reluctant to accept a solution that addresses only the amount of the payment without an accompanying reduction in the balance due on the loan," said Barbara Desoer, president of Bank of America Home Loans, in a prepared statement.